TUESDAY, JANUARY 22, 2013
Why financial markets are inefficient
By Roger E. A. Farmer, Distinguished Professor and Chair of the Economics Department, UCLA. Originally published at VoxEU.
Writing in a review of Justin Fox’s book The Myth of the Efficient Market, Richard Thaler (2009) has drawn attention to two dimensions of the efficient markets hypothesis, what he refers to as:
- ‘No free lunch’, what economists refer to as ‘informational efficiency’;
- ‘The price is right’, what economists refer to as ‘Pareto efficiency’.
My recent research with various co-authors argues that while there are strong reasons for believing there are no free lunches left uneaten by bonus-hungry market participants, there are really no reasons for believing that this will lead to Pareto efficiency, except, perhaps, by chance (Farmer, Nourry, Venditti 2012).
In separate work, I look at the policy implications of this, showing that the Pareto inefficiency of financial markets provides strong grounds to support central bank intervention to dampen excessive fluctuations in the financial markets (Farmer 2012b). These are strong and polarising claims. They are not made lightly.
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